Cheques and cheque clearing

Although cheque usage has declined in recent years as businesses have started to use automated payments and cards, it still remains a very important payment method, particularly for small businesses.

The clearing system

Cheques are paper items which are physically transferred between banks at the same time as the electronic data is processed. Although the paying bank receives some of the data electronically, the physical cheques themselves must also be transferred so that they can be examined by the paying bank for security and fraud prevention purposes.

The clearing system works within a three working day period (it does not operate on Saturdays, Sundays or Bank Holidays).

Day 1

When a cheque is paid into an account (at the collecting bank) it is sent to the bank's clearing centre at the end of the working day.

Day 2All cheques received are sorted at the clearing centre and the sort code, account number and serial number on the bottom of the cheque, together with the amount of the cheque, are sent electronically to the banks on which they are drawn (the paying bank) by 11am. The physical cheque is then sent to the bank on which it is drawn.

Day 3The paying bank debits the payer's bank account with the amount of the cheque on the morning of day 3. At the same time, all banks calculate the amount they must pay each other on the basis of the value of all the cheques exchanged on the previous day. The net balances are then settled across accounts held at the Bank of England.

This is the end of the central clearing cycle.

However, if the paying bank was unable to pay the cheque, for instance if the cheque owner has insufficient funds in their account, placed a stop on the cheque, or filled it out incorrectly, it would return the cheque to the original collecting bank on day 3, or in certain specific circumstances, by 12 noon on day 4. Cheques are generally returned by first class post, so the earliest the collecting bank will know that the cheque will not be paid is day 4, or possibly day 5.

A cheque may be returned later than day 5 if it is found to be fraudulent. For instance if a fraudster has bought goods using a stolen cheque, the genuine owner may not discover until sometime after the goods have been exchanged that money is missing from their account. In this case, the money that has been paid into the seller's account belongs to the genuine cheque owner and could be withdrawn once the fraud is discovered. If you accept a cheque that subsequently turns out to be fraudulent, you may be required to return the funds. See the section below for tips on Avoiding Cheque Fraud.

Individual banks set their own policies on the point at which they credit funds on cheques paid into their customers' accounts. Under The Banking Code, banks are required to provide clear details of their policies on the issues to their customers, and whether they add extra days to the central clearing cycle. Most high street banks allow customers to withdraw funds on the fourth or fifth working day, but some banks allow customers to withdraw funds as early as day 1.

Cheque guarantee services

Some specialist private companies offer cheque clearance and collection services. Here they advise you before the cheque enters the clearing system if it is likely to be honoured. If they approve the cheque and it is later returned by the bank, the company will reimburse you.

They will also follow up on returned cheques and arrange prompt repayment of the debt. They often operate on a no collection, no fee basis.

Banks also offer cheque guarantee cards, where one cheque per transaction is guaranteed up to the value limit shown on the accompanying cheque guarantee card.

Receiving cheques

Always ensure you know the creditworthiness of your customers to minimise the risk of a bounced cheque as accepting a cheque for payment does not necessarily mean payment will be made. For high value payments consider using more secure methods of payment such as CHAPS (formerly known as a telegraphic transfer).

Shop around for an account that provides the best service for your needs as different banks have different policies on when customers may withdraw funds from cheques.

Pay cheques into your account straight away to reduce the risk of loss or theft.

Consult your bank on the best payment method when dealing with cross-border customers, as foreign cheques cannot be cleared through the UK cheque clearing system and will therefore add time and cost to the payment.

Issuing cheques

Do not use post dated cheques as they may cause problems if paid in before the date shown by being returned unpaid or being cleared before you are expecting it.

Always keep cheque guarantee cards and cheque books separate.

Help prevent fraud by adding extra information on the payee line after the name such as invoice or contract numbers.

Draw a line through unused space on the cheque to avoid unauthorised people adding extra details.

Record details of cheques issued on chequebook counterfoils and carefully check against bank statements so discrepancies can be picked up and reported to your bank or building society.

Try to allocate responsibility for issuing cheques and undertaking reconciliation with bank statements to at least two different people.

Consult your bank on the best payment method when dealing with cross-border suppliers, as cheques issued by UK banks (even if denominated in another currency) are for use in the UK only.

Avoiding cheque fraud

The industry is fighting fraud through the Cheque Printer Accreditation Scheme which lays down security standards for printing cheques to protect against counterfeiting and fraudulent alteration of cheques. In addition, the Dedicated Cheque and Plastic Crime Unit, funded by the banking industry targets organised criminal gangs heavily involved in counterfeiting.

The banking industry continues to identify most fraudulent and stolen cheques as they pass through the clearing system before there is a victim, but there are several ways businesses can help to guard against fraud:

Don't accept a cheque, or banker's draft from someone unless you absolutely know and trust them.

Remember that, even after the value of the cheque has been credited to your account there is still a risk that the money could be reclaimed if the cheque turns out to be stolen or counterfeit.

Consider other types of payment for high-value goods and services such as automated payment or CHAPS – if the customer is unwilling to pay, or share with you, the relatively small cost involved with CHAPS, then seriously consider if you should be doing business with them.

Be aware that banker's drafts and building society cheques are not necessarily safe forms of payment, as the money may not be paid if they are found to be stolen.